By Ryan Ellis
The House of Representatives will soon consider what has come to be known as “ Tax Cuts 2.0.”Among other things, this package of bills will make permanent the temporary individual tax cuts in the tax reform law passed in December 2017. This includes provisions like permanently lower individual income tax rates across the board, a doubling of the standard deduction, and a doubling of the child tax credit.
What you might not know is that for the 4.5 million families formerly in the Alternative Minimum Tax, the state and local tax deduction part of tax reform is a huge improvement over prior law.
Included in Tax Cuts 2.0 will be to make permanent the $10,000 limit on state and local tax deductions and the de facto elimination of the alternative minimum tax. National Democrats and a sometimes-obsessed media have tended to not only focus on the SALT provision disproportionately, but also talk as if the SALT provision is the entirety of the tax picture for individuals. In fact, it’s the interaction of the SALT deduction and the AMT that they should be focusing on, among other context items.
Blue area voters in places like New Jersey, New York, and California have been told time and again that they are getting a big tax hike due to the SALT cap. In fact, almost all of these voters are getting significant net tax relief — thousands of dollars per year for families with children and small employers. Lower tax rates across the board and a more generous child tax credit will tend to do that for you.
According to the liberal Tax Policy Center, for example, 90 percent of families in New Jersey are enjoying tax relief or no tax change at all (probably because their income taxes were already zero). Those who get tax relief are getting an annual tax cut of more than $2,700. That’s with the SALT limit in place. Those very few who may in theory end up with higher taxes tend to fall into households making multiple six-figure incomes and can plan around the law changes. The percentage of families with no income tax liability at all will increase from 42 to 44 percent nationally.
In fact, the SALT part of tax reform can only be understood for blue area voters in the context of AMT repeal. According to the same Tax Policy Center, 4.5 million families paid the AMT (a parallel tax system which, among other things, disallows SALT deductions altogether) before the Tax Cuts and Jobs Act basically repealed it.
The three states mentioned above — New Jersey (280,000 AMT families), New York (514,000 AMT taxpayers), and California (900,000 AMT victims) — have a disproportionate share of formerly AMT households. For these families, their SALT deduction prior to tax reform was $0. By dint of being in the AMT, they didn’t get a SALT deduction at all.
The Tax Cuts and Jobs Act did two things for these 4.5 million families — first, it got them out of the AMT. This means they get to join the rest of us in the normal tax system and can plan their tax lives accordingly. Second, by getting them out of the AMT, these 4.5 million families now are able to deduct up to $10,000 of state and local income and property taxes. Before, they couldn’t deduct anything.
The IRS has also recently improved the SALT picture for taxpayers in these states. In a ruling last week, the IRS said that unincorporated businesses like sole proprietorships, partnerships, LLCs, and Subchapter S-corporations (all of whom pay taxes in the individual system) could donate to state charitable programs which provide dollar-for-dollar offsets of state income tax liability. Provided there is some marketing or other benefit for the donating business, the contributions could then be deducted as an ordinary and necessary business expense on individual tax returns’ business schedules. Essentially, this mechanism allows flow-through firms to avoid the SALT limitation altogether, at least when it comes to state income tax. These business owners can also take full advantage of their $10,000 SALT deduction when it comes to property tax.
It’s also important to note that most people won’t be thinking about the SALT deduction at all anymore since it’s an itemized deduction and most families will now be using the doubled standard deduction. According to Congress’ nonpartisan Joint Tax Committee, the percentage of families foregoing itemized deductions like SALT and choosing to claim the bigger standard deduction instead will rise from 70 percent of households before tax reform to almost 90 percent of households this year.
Even in a heavy SALT state like New Jersey, 60 percent of tax returns didn’t claim the SALT deduction, and that’s before tax reform doubled the standard deduction. Analysts can reasonably expect the SALT issue to be one for the top 15 or 20 percent of Garden State taxpayers going forward (and even they will have workarounds, as seen above), which is not at all consistent with how the media has reported on the issue there or nationally. It’s not a middle class problem at all, but rather an affluent class tax planning challenge.
As always in tax policy, context matters. If you were one of the 4.5 million families in the dreaded AMT, your SALT deduction actually increased from $0 to $10,000. If you are a small business owner in a state with high state income taxes, there’s a good chance a state-established charity provides a good tax planning opportunity to deduct these taxes instead on your business returns. And if you’re like most folks, you’re not going to notice or care about any of this chatter — you will take the standard deduction instead.
Learn more here.